Halogen is a Canadian-based software company, trading on a Canadian exchange, selling talent management software to mid-sized companies, primarily in the U.S. Later in the letter, we discuss the importance of simple math. In the case of Halogen, part of the simple math relates to currency conversion. Halogen’s share price is denominated in Canadian dollars; with today’s exchange rates, a Canadian dollar equates to around 80 U.S. cents. Other than share price, every other number for Halogen – including cash on the balance sheet and revenues – is valued in U.S. dollars.

When converting the currency properly (not clear that everyone does this basic math correctly), Halogen has just about the lowest Enterprise Value (Market Cap less Cash)/ Revenue of any company we know of that is not facing some sort of terminal decline. Specifically, at $7 (CAD) – where we bought a lot of additional shares – the company had an EV of less than $85M USD and revenue (growing 10%+) of $65M, so it was effectively at an EV/Rev of 1.3X when SAAS companies will typically trade anywhere from 2X-8X depending on growth rates, margins and the competitive landscape. We would typically focus on cash flow, but in the case of a growing SAAS software company with strong unit level economics (positive lifetime value of a customer), sales and marketing to acquire even more customers is expensed immediately (not capitalized) and distorts the Price to Earnings and Price to Cash Flow metrics. The valuation is not demanding.

The largest problems with Halogen are that customer acquisition costs have risen and growth has slowed. By my estimates, which I shared with management, Halogen is paying approximately $55K to acquire each new customer, but the company was only being valued at less than $40K per existing customer when using the public market enterprise value/# of customers. My argument to management was that it is cheaper to buy back stock than go and acquire new customers. The company has since put in place a large buyback for 1.2 million shares (5% of the outstanding shares), and fortunately, given the large cash balance, Halogen can buy back shares and still acquire new customers.

The new CEO is outstanding and has embraced a partnership model to acquire customers more efficiently. I think he is making very sound decisions and look forward to the progress the business makes. The combination of a low multiple and improved marketing efficiency could be a powerful catalyst for future returns. The HR software space is undergoing consolidation as companies go from offering piecemeal solutions, such as payroll, benefits management, or talent management, to offering a complete suite of solutions. Given the current valuation, the corporate overhead that could be stripped out by an acquirer, and the lowered customer acquisition costs if folded into a larger company with an existing customer base to sell into, the economics for an acquirer would make sense even at twice today’s share price.

Scott Miller is an instructor at Wide-Moat Investing Summit 2016.


This post has been excerpted from the Greenhaven Road Capital Q1 2016 Letter.

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